FoolsGold

GILLIANTETT

HachetteDigital

wwwlittlebrowncouk

TableofContents

TitlePageCopyrightPageDedicationPrefacePARTONE-Innovation

CHAPTERONE-TheDerivativesDreamCHAPTERTWO-DancingAroundtheRegulatorsCHAPTERTHREE-TheDreamTeamCHAPTERFOUR-TheCuffsComeOffCHAPTERFIVE-MergerManiaPARTTWO-Perversion

CHAPTERSIX-InnovationUnleashedCHAPTERSEVEN-MrDimonTakesChargeCHAPTEREIGHT-RiskyBusinessCHAPTERNINE-LeveragingLunacyCHAPTERTEN-TremorsPARTTHREE-Disaster

CHAPTERELEVEN-FirstFailures

CHAPTERTWELVE-PanicTakesHoldCHAPTERTHIRTEEN-BankRunCHAPTERFOURTEEN-BearBlowsUpCHAPTERFIFTEEN-FreefallEpilogueNotesGlossaryAcknowledgementsIndex

FoolsGold

GILLIANTETT

HachetteDigital

wwwlittlebrowncouk

CHAPTERTWELVE-PanicTakesHoldCHAPTERTHIRTEEN-BankRunCHAPTERFOURTEEN-BearBlowsUpCHAPTERFIFTEEN-FreefallEpilogueNotesGlossaryAcknowledgementsIndex

FoolsGold

GILLIANTETT

HachetteDigital

wwwlittlebrowncouk

FoolsGold

GILLIANTETT

HachetteDigital

wwwlittlebrowncouk

PublishedbyHachetteDigital2009

CopyrightcopyGillianTett2009

Allrightsreserved

Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis

conditionbeingimposedonthesubsequentpurchaser

ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary

eISBN9780748112210

ThisebookproducedbyJOUVEFRANCE

HachetteDigitalAnimprintof

LittleBrownBookGroup100VictoriaEmbankment

LondonEC4Y0DY

AnHachetteLivreUKCompany

ForAnalieseandHelenMarie

PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely

greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare

Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness

Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment

fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives

OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion

First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters

Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur

in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo

Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

ForAnalieseandHelenMarie

PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely

greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare

Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness

Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment

fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives

OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion

First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters

Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur

in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo

Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely

greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare

Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness

Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment

fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives

OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion

First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters

Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur

in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo

Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives

OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion

First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters

Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur

in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo

Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo

Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest

Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo

lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow

lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret

I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored

Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

PARTONE

Innovation

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

PARTTWO

Perversion

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

PARTTHREE

Disaster

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

Epilogue

On29January2009JPMorganChasehostedacocktailpartyfortwohundred

ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking

CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from

Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe

Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying

toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke

volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit

hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos

Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat

Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained

Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis

fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the

traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s

hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational

creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson

270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare

pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she

pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone

couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis

to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof

2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere

advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake

senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former

chairmanoftheFederalReserveintheautumnof2008markedanintellectual

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008

turningpointDuring the previous two decades Greenspan had vehemently championed

unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team

observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance

ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould

seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour

collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas

that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad

devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible

macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory

structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too

manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from

ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld

Notes

NOTESONSOURCES

Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008

CHAPTERONE

4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994

11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt

12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4

15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001

22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit

24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008